ARE INDEPENDENT CENTRAL BANKS PASSÉ?

FEB 26, 2020 HOWARD DAVIES

US President Donald Trump’s decision to nominate economist Judy Shelton for one of the
vacant positions on the Federal Reserve Board has put the future of central bank
independence back on the agenda. Shelton has cast doubt on the desirability of, and legal
basis for, Fed independence, saying last year, “I don’t see any reference to independence in
the legislation that has defined the role of the Federal Reserve.” And she has argued for “a
more coordinated relationship with both Congress and the President.” If Fed policy were
“coordinated” with Trump, then it is fairly clear who would be calling the shots.

It is not only in the US that central-bank independence is under threat. In Turkey, President
Recep Tayyip Erdoğan fired his governor last year, saying that “we told him several times to cut
interest rates,” but he did not oblige. In India, the government asked the Reserve Bank to hand
over some of its reserves, and Governor Urjit Patel resigned “for personal reasons." A few
months earlier, his key deputy had directed a broadside at Prime Minister Narendra Modi’s
administration: “governments that do not respect central bank independence will sooner or
later incur the wrath of the financial markets.”

Central banks around the world are worried by these straws in the wind. Otmar Issing, the first
chief economist of the European Central Bank, has written of the “the uncertain future of
central bank independence.” The ECB’s then-president, Mario Draghi, was moved to issue a
firm defense of the concept before he left his post. The Bank for International Settlements has
noted “the extraordinary burden placed on central banking since the [2008 global financial]
crisis,” and warned that central banks cannot deliver on the expectations people have.

Are these prophets of doom correct? Will we soon see control of interest rates back in the self-
interested hands of finance ministries? In the words of the song, was central bank
independence just a silly phase we were going through?

I think not. The most recent global survey, by the economists Nergiz Dincer and Barry
Eichengreen, though admittedly conducted in 2014, shows that there is still a “steady
movement in the direction of greater transparency and independence over time (and) little
indication these trends are being rethought.” One might have some grounds for skepticism
about the measures of independence they use – according to their model, Kyrgyzstan boasts
the world’s most independent central bank – but they can find no cases where changes to
legislation bringing the central bank back under political control have been implemented.

In the West, while Trump has huffed and puffed, he appointed Powell, a man with
conventional instincts and a backbone. British Prime Minister Boris Johnson resisted the
temptation to appoint a Brexit supporter to the Bank of England and named a veteran BOE
insider, Andrew Bailey, who has independence in his bones. In the eurozone, a similarly neutral
choice emerged as Draghi’s successor, and a change in the ECB’s status would require a new
European Union treaty. The chances of that are vanishingly small. EU leaders show no
indication of taking the risk of opening up the constitution to further referenda, as would be
necessary in some countries. Furthermore, some of the political pressure for action has
diminished. Trust in the ECB fell sharply after the eurozone crisis nearly a decade ago, but has
recovered in most countries in the last couple of years. Even in Greece, the ECB is trusted more
than the national government.
Should central banks regard this renewed disputatiousness as a bad and dangerous thing?
They may, if they wish, but I suspect they are pushing water uphill. We have moved into a less
respectful age, which is not surprising, given the mistakes made by central banks (and others)
in the run-up to the 2008 crisis. Instead of bemoaning the surge of comment and challenge,
central banks need to raise their game, enhance their transparency, and get better at
explaining and justifying their actions and decisions.

Andy Haldane, the BOE’s chief economist, has shown that much of what central bankers say is
incomprehensible to all but a small proportion of the population. Only 2% of the population
can readily understand the minutes of the Fed’s Open Market Committee, which sets interest
rates, while 70% can understand a Trump campaign speech. That gap needs to be closed, and
central banks should make their work more accessible to the public. Maybe a collective trip to
Kyrgyzstan is in order to observe best practice in action.